zero-coupon and STRIPS government, principal, payments, separate, dealers

glamorous

hi All,
i'm a bit confused. according to the CFA1 Curriculum Vol 5, Reading 64, page 455, "Treasury STRIPS", "...the U. S. Department of the Treasury doesn't issue zero-coupon treasury securities with maturity greater than one year". But government dealers can do that-they separate the "coupon payments and the principal payment ..."

my questions are: (1) are those securities thus issued (by the gov't dealers) no more "zero-coupon" securities? (2) if they are, why are they "stripped" into "coupon payments" and "principal payment"? (they are "zero-coupon" securities, so why "coupon payments"?) or does the "stripping" process change those securities from "zero-coupon" to "coupon-paying" securities?

koba

shootingstar

ok, haven't revised this chapter, but from what i can remember:

STRIPS are created by the process of taking a coupon-bearing Treasury and stripping it down into all of its different parts.

eg let's take a 5-year coupon-bearing treasury. What actually is this? -- it's a series of 10 coupon payments and then the principal repayment at the end.

Therefore you can "strip" it down into 10 coupon strips with differing maturities, and the principal "strip", and sell those all off separately as 11 zero-coupon securities.

hope that helps.

JRossSter

koba Wrote:
-------------------------------------------------------
> hi All,
> i'm a bit confused. according to the CFA1
> Curriculum Vol 5, Reading 64, page 455, "Treasury
> STRIPS", "...the U. S. Department of the Treasury
> doesn't issue zero-coupon treasury securities
> with maturity greater than one year". But
> government dealers can do that-they separate the
> "coupon payments and the principal payment ..."
>
> my questions are: (1) are those securities thus
> issued (by the gov't dealers) no more
> "zero-coupon" securities? (2) if they are, why
> are they "stripped" into "coupon payments" and
> "principal payment"? (they are "zero-coupon"
> securities, so why "coupon payments"?) or does the
> "stripping" process change those securities from
> "zero-coupon" to "coupon-paying" securities?
>
> koba

(1) exactly, the government issues only coupon paying securities when maturity > 1 year
(2) Each strip or the principle as a separate piece represents a single payment, hence a zero-coupon bond. the stripping process change those securities from a coupon paying security to zero-coupon paying securities.

example. 2 year 5% Treasury bond semiannually could be stripped into 5 zero-coupon bonds:
1 5% zero coupon bond with 0.5 year maturity
1 5% zero coupon bond with 1.0 year maturity
1 5% zero coupon bond with 1.5 year maturity
1 5% zero coupon bond with 2.0 year maturity
1 100% zero coupon bond with 2.0 year maturity

mnieman

hi Kiakaha.
if you can talk about/explain STRIPS like that, though you've not revised the chapter, then you don't need to revise. you already have everything!
my problem/question is: if those securites thus created through the "stripping" process are still called "zero-coupon securities" (after the "stripping" process), why will there be "coupon payments"-my confusion is about those "stripped" securities having "coupon payments", even though they are called or named "zero-coupon" securities.

i'm sorry to bother you that much.

thanks.

ftwcfa

hi koba,

stripped securities don't make coupon payments. You might be getting confused by the term "coupon STRIPS": this means it was created from what was originally a coupon payment (as part of the original coupon-bearing Treasury).

However, it's now a zero-coupon security that pays investors a single amount (the size of the original coupon) at maturity.

Effectively, what was a coupon payment on the original treasury has become the principal on the stripped security.

cheers!

amqata

thanks a lot! i got it.